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Soft budget constraint and stock price information

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  • Faure-Grimaud, Antoine

Abstract

This article investigates the ability of regulatory agencies to keep firms to fixed budgets. The budget implemented at an interim date is always superior to the one efficient ex ante, since, at the interim stage, regulators do not internalize the disincentive effect of their intervention on firm's effort. Budget constraints are more or less soft according to the information available to regulators. The ability of financial markets to generate information is endogenized. It is shown that stock price information may increase the softness of the budget constraint, decrease firms' incentives to exert effort and may reduce social welfare. It also appears that the "softness" of these constraints depends on the type of claims used to finance initial investments. A straightforward application of the model sheds light on the privatisation decision.

Suggested Citation

  • Faure-Grimaud, Antoine, 1996. "Soft budget constraint and stock price information," LSE Research Online Documents on Economics 119157, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:119157
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    File URL: http://eprints.lse.ac.uk/119157/
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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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